Beyond Bulls & Bears

Growth and Value in Asia – Not Mutually Exclusive

Figuring out how to invest in Asia can sometimes feel like trying to solve a Japanese puzzle box. In some countries, economic growth is robust, yet stock markets are sluggish. At the same time, equity valuations can be rather expensive. But growth and value don’t have to be mutually exclusive ingredients in an equity portfolio. Hong-Kong based Simon Rudolph, executive vice president, portfolio manager and research analyst at Templeton Global Equity Group, believes active strategies are the key that might help solve the puzzle for investors desiring both. 

Small is Beautiful  [php function = 1]

For a blend of value and growth, Rudolph favors Asia’s large (and largely unexplored) universe of small and mid-size companies. He’s found growth-oriented companies in Asia that he thinks look inexpensive relative to their long-term earnings potential, for a variety of structural reasons. These stocks might not be the common names you might find heavily weighted in popular equity benchmarks.

Simon Rudolph

Our team’s preference is to avoid the largest of the large index names in most sectors, unless we have a very strong conviction those shares are mispriced. This tends to only happen at extremes of excessive pessimism or optimism. That leads our team of analysts to seek smaller companies, but they may be too small to give the total exposure required to capture a particular story. Hence, we may need to find three or four companies in order to meet our goals. Mid-cap stocks are also important, as they can offer exposure to lesser-known companies with good potential for growth, with less liquidity problems that some small-cap stocks can be subject to.

To add value, we like to examine stocks we think other analysts may be overlooking or doing less sophisticated analysis on, and determine whether the reports put fair value on the stock. I have personally experienced how this works because 25 years ago, I was a junior analyst in Europe and I understand the opportunity that analysis gaps can provide to careful investors.”

Actively Adding Value

One example of this investment process in action is crude palm oil. In Asia, it’s is widely used for cooking, and demand tends to increase with rising incomes. To take advantage of this trend, what kind of company might an active manager look to invest in? A few thoughts on how Rudolph approaches it:

“Two things tend to affect the share price of palm-oil producers: the price of the commodity itself, and production volumes. In Asia, due to geographic realities, the producers are located only in Malaysia and Indonesia. Many of the more established companies in this area have already reached capacity in their production ability, so their share prices are influenced mainly by the price of palm oil. That is not where we prefer to invest, however. We seek out upstream producers that still have plenty of land yet to be planted out. These are immature companies whose production will not likely peak for years.”

Rudolph concedes that companies in Malaysia generally do not have much unplanted land, but there are plenty of families in Indonesia that went into the business after the Asian financial crisis in the late 1990s, and are just now ramping up. As you might imagine, understanding this level of detail in the market requires a lot of homework.

“In this case, learning about the lifecycle of palm oil trees is paramount. These trees typically only begin to yield oil in their fourth to eighth years. They are most productive, however, in the eighth through the 20th year, after which their yields taper off. So the trick is to find companies that today are planting young, immature trees. We believe that can act as a potential safeguard to an investment over the next decade or more, and tactically it gives us two ways to evaluate the company’s share price: by both palm-oil prices as well as their production potential.”

Such stories or themes are becoming increasingly common throughout Asia, as more families list assets and new sectors take off. Rudolph says he sees a transformation taking place across Asian economies, creating entirely new ways for equity investors to tap into Asia’s growth potential. Real estate investment Trusts (REITs) are one example. In addition, the region is quite diverse, with a mix of highly developed, sophisticated markets as well as emerging markets, which tend to have higher growth rates and consumer growth potential.

Bargain-Hunting

While, many equity investors have found the Asian story compelling, Rudolf acknowledges that not all sectors provide equal value.

“Certain areas have definitely overrun themselves. This is often because investors face a lack of choice. If you want a domestic healthcare company, for example, you may be asked to buy it at 30x expected earnings. What that means for most asset managers is that to buy that stock means you must be confident the company’s earnings growth will continue uninterrupted for the foreseeable future. That may happen, but it also increases the potential downside if the company hits a speed bump.

Equally, our team examines the global issues that can affect many companies around the region. China is tied to the West by exports, and many Asian countries are similarly tied to China. Foreign investment inflows can help a country’s stock market and currency rise, but during periods of global risk aversion, those outflows are going to have the opposite effect. The Philippines is a good example of a stock market affected by the “risk-on/risk-off” decision. From our point of view, we only add a company to our portfolio if it is fundamentally undervalued.”

To Rudolph, valuation depends in part on a portfolio manager’s confidence in how companies are being managed.

“We believe managements around the world choose to either be ethical or not. It is up to the asset manager to assess a locale’s legal system and a corporation’s friendliness to minority shareholders, and factor that into the stock’s price. We follow a disciplined, principled process, based on where we think we can add value and where we can manage risk. We take our jobs seriously. And we stick with common sense: don’t overcomplicate things, don’t trade too much, and leverage what we know well.”

Sir John Templeton knew that a long-term investment approach is like the palm tree that needs time to grow before producing its bounty. “The investor who selects stocks on the basis of long-term intrinsic value should not expect that the stocks selected will immediately begin to show a profit.” In other words, both require some patience.

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What are the Risks?

The value of investments and the income from them can go down as well as up and you may not get back the full amount that you invested. Past performance is not indicative of future performance Special risks are associated with foreign investing, including currency fluctuations, economic instability, and political developments. Investments in developing markets involve heightened risks related to these same factors. Investments in developing markets involve heightened risks related to the same factors, in addition to those associated with their relatively small size and lesser liquidity.